ECB raises interest rates to curb rising prices in the eurozone
The European Central Bank has raised interest rates by 0.25 percentage points as the ongoing Middle East conflict keeps pushing up energy costs and inflation in the eurozone. Bank of Estonia's Ulo Kaasik says risks remain elevated, though the region's economy has stayed resilient.
The Governing Council of the European Central Bank has decided to raise interest rates by 0.25 percentage points in an effort to bring eurozone inflation back to its two-percent target. The deposit rate, which has the greatest impact on financial markets, has now risen to 2.5 percent. The analysis comes from Ulo Kaasik of the Bank of Estonia.
The Middle East conflict, now lasting more than half a year, continues to push up energy prices and thereby fuel overall inflation. In August, eurozone inflation accelerated to 3.3 percent, up from 2.9 percent in July, driven largely by more expensive energy. A sharper price jump was avoided thanks to slower-than-expected growth in food prices.
Energy price risks persist
Oil has climbed to $100 per barrel, but a bigger concern is the surge in European gas prices, which have risen almost 2.5 times compared with last year, from 33 to 80 euros per megawatt-hour. Gas nonetheless remains considerably cheaper than in 2021 and 2022, when prices peaked at around 340 euros per megawatt-hour in August 2022.
While slower food price growth has offered some relief amid high overall inflation, this relief could prove temporary. Risks of renewed food-price acceleration remain, driven by factors such as rising global grain prices, weather anomalies linked to El Nino, and the pass-through of higher energy and fertilizer costs into final food prices.
Economy remains resilient
Despite the difficult environment, the eurozone economy has shown solid resilience, with GDP growing 1.2 percent in the second quarter compared with the same period last year. Both consumption and exports stayed strong, with growth also supported by higher public-sector spending. Some slowdown is expected in third-quarter data, however, as summer heat disrupted shipping on the Rhine, reduced electricity output due to water shortages for cooling power stations, and hurt the agricultural sector.
In September, the ECB revised its economic forecast for coming years, again basing it on several alternative scenarios given exceptional uncertainty. Markets expect the conflict's impact to ease next year, helping inflation move closer to the two-percent target, though the risk of inflation coming in higher than projected remains significant. Despite the energy shock, the eurozone economy is still forecast to grow — by 1.4 percent in 2027 and 1.5 percent in 2028 — good news for Estonia as well, given its economy's close dependence on its key trading partners.
Alongside short-term rates, interest rates on long-term government bonds have also risen quickly, reflecting financial markets' concerns about rapidly growing debt, amplified by a larger volume of bonds issued to fund artificial intelligence investments. This matters for Estonia too, since borrowing to cover its large budget deficit will now come at a higher cost.
